Notes

The stock market is where investors can trade in different financial instruments, such as shares, bonds and derivatives. The stock exchange is a mediator that allows buying/selling of shares.

Bull markets vs. bear markets

A bull market typically means investors are confident, which indicates economic growth. A bear market shows investors are pulling back, indicating the economy may do so as well.
The good news is that the average bull market far outlasts the average bear market, which is why over the long term you can grow your money by investing in stocks.

Stock market crash vs. correction

A stock market correction happens when the stock market drops by 10% or more. A stock market crash is a sudden, very sharp drop in stock prices, like in early 2020, around the beginning of the COVID-19 pandemic.
While crashes can herald a bear market, remember what we mentioned above: Most bull markets last longer than bear markets — which means stock markets tend to rise in value over time. In 2020, the market was back to hitting record highs by August.
Why? Because when you sell investments in a downturn, you lock in your losses. If you plan to re-enter the market at a sunnier time, you’ll almost certainly pay more for the privilege and sacrifice part (if not all) of the gains from the rebound.

The importance of diversification

You can’t avoid bear markets as an investor. What you can avoid is the risk that comes from an undiversified portfolio.


To smooth out that company-specific risk, investors diversify by pooling(( multiple types of stocks together)), balancing out the inevitable losers and eliminating the risk that one company’s contaminated beef will wipe out your entire portfolio.


Stockbrokers: Stockbrokers are the members of exchanges. They are the intermediaries who execute the buy and sell instructions from investors in exchange for fees. In the Indian setup, investors need to trade through broking houses/brokers, who act as facilitators.


Investors and traders: There are two types of players in the market – investors and traders. Investors buy company shares to hold them for the long-run and generate a source of income from it. Traders are the opposite of investors and get involved in buying and selling of equities.

Investors are motivated by company performance, long-term growth opportunities, dividend payouts, and other such factors. Traders, in contrast, are influenced by price movement and demand and supply factors.

Now, let’s talk about the two types of markets we have mentioned above.

Trading in the stock market is a process of matching the buyer to the seller. Your broker passes on your buying request to the stock exchange, which then compares it with a seller. Once the trade is fixed and the price agreed, the exchange informs your broker about it, and the transaction takes place. Meanwhile, the bourse confirms information regarding the buyer and the seller so that parties don’t default. The actual transfer of stocks then takes place to complete trading.

Earlier, the process took days, but digitisation helped reduce the time to T+2, that is, within two days of the transaction and the process of bringing it down to T+1 is underway.

Important concepts to know
(i) Moving averages – Derived from stock history, they show the general trajectory of a stock and where it is likely to be headed.

(ii) Business cycle – This cycle follows an emotional cycle wherein market fear follows market greed followed by fear again. The best time to buy stockis at its peak which is when the economy is in a recession and it is possible to avail of stocks at low prices. Conversely, when the economy booms, the prices of stocks soar and allow traders to cash in, realising gains should they sell their shares.

(iii)Diversification – Investing in a wide variety of stocks spread over diverse sectors, is ideal as it cushions traders against inevitable market setbacks and reduces volatility.

(iv) Price of a stock – Stocks shouldn’t be viewed and bought based on their price alone. Consider whether it is overpriced or underpriced as well as other issues such as the condition of the economy or the sector.

(v) Traders must know the sort of buy or sell order they enter into which can be restricted by price or time frames – Limit orders are those orders which are only carried out by stockbrokers provided the price matches what the trader wishes them to be. Stop-loss orders are given to stockbrokers by traders to prevent a big drop in the value of their stocks.


Risk Management strategies

Portfolio Diversification: Investors can opt for more than one financial instrument to diversify their portfolios and further diversify investing in financial products of different companies belonging to distinct sectors. A diversified basket may provide a shield if any industry or company moves in an unfavourable direction.

Practice rupee cost-averaging: All you need to do in this approach is to buy shares regularly – some of these shares purchased by you will be cheaper than others. Over the long run, the buy costs will average out, and what will stand out is the growth of these small, compounding investments.

Stop Limit: If in case the market moves in an unfavourable direction than intended, you can cap your losses by placing the following orders with Angel One,


3. Mark to Market(MTM) margin
MTM is calculated at the end of the day on all open positions by comparing the transaction price with the stock’s closing price for the day.

For instance, if you buy 100 shares of ‘X’ at ₹100 at 11 AM on a trading day ‘T’ and if the closing price of the shares on that day happens to be ₹75, then you will face a notional loss of ₹2500 on your buy position. This loss is termed as MTM loss and is payable on ‘T+1’ day before the opening of the trade.


4. Initial/SPAN margin
The initial margin for the F&O segment is calculated on a portfolio (a collection of futures and option positions) based approach. The margin calculation is carried out using software called – SPAN (Standard Portfolio Analysis of Risk).

SPAN generates about 16 different scenarios by assuming different values to the price and volatility. For each of these scenarios, the possible loss that the portfolio would suffer is calculated. The initial margin required to be paid by the investor would be equal to the highest loss the portfolio would suffer in any of the scenarios considered. The margin is monitored and collected at the time of placing the buy/sell order.


Myths about stock market


Myth 1: Trading in stock market = Gambling
The generic sentiment of people about trading is that it’s a gamble, either you win or lose.

Myth Busted

Investing is more like science where you need to do proper research about the fundamentals and technicals of the securities, current market trends, and growth prospects of the company.

Myth Busted

Investing decisions are based on the future of the company and not just the historical trends. Interest rate, GDP, exchange rate, etc. are some of the major macroeconomic variables that affect the performance of the stock. Investors must also consider quarterly earnings, level of competition, cost of production, new product launch, change in top management, etc.

Myth 3: Stock that comes down, will go up eventually or vice v


When a stock falls, investors need to research the reasons for the fall. Is the decline only due to market sentiment, which may reverse; or is the fall due to some significant event that may hurt the financials of the company? Also, just because a stock has seen a sharp rally, does not mean it cannot appreciate further.


Myth Busted

The truth is quality trades are better than quantity trades. You can do a number of trades without proper research and not earn desired returns. On the other hand, if you invest after thorough research and do quality trades, you might earn good returns.

Prices are high relative to fundamental valuation | Peak Valuations: During a stock market bubble, the prices are just pushed up by the sentiment of the market and the herd mentality. Simply put, the fundamentals of a company are not increasing at the same pace as its stock price.

Popularisation of a trend | Behavioural Finance– Sometimes narratives of bull markets overpopularise themselves. The hype around some stocks causes the prices to rise up exponentially, which leads to a bubble.

PE Ratio – To understand whether the stock markets or company is overvalued, a good indicator is the PE ratio.

PE ratio = price per share / earnings per share

Historically the Nifty PE ratio ranges between 15-25. In the event that the PE ratio falls below 20, you can say that the market is undervalued. PE ratio between 20-25 indicates that the market is fairly valued. If the PE ratio crosses 25, then the conclusion is that the stocks are overvalued. To understand this a bit better, let’s look at an example.

Besides this, several more indicators such as the Buffet Indicator, SmallCap Index, and the Sensitivity Index help identify a stock market bubble. However, these indicators are not always accurate in predicting the bubble.